|EVA Drivers: the DNA of value creation|
Observing the statements made by many companies leaves no doubt that the objective of these organizations is to create value for their shareholders. This goal can be defined in practical terms as the maximization of a company’s future Economic Value Added (EVA), in other words, the net operating results of the invested cost of capital. It is also known that a powerful instrument to align the interests of management and shareholders is to establish compensation plans that reward the achievement of this purpose. These statements are widely known by scholars and/or practitioners of corporate finance. However, how can all of these aspects be conveyed to the managers that are not at the top of the organization or don’t have detailed knowledge of these issues?
The first aspect to be addressed is the EVA concept. Depending on how a company is structured, this indicator can lose visibility at the lower rungs of the hierarchy. This happens because a performance measurement based on consolidated numbers is far away from the reality of middle and low management. In microeconomics it is said that the decision powers of these collaborators are tied to a small part of the company and not the entire organization.
The second aspect is that some – or sometimes most – decision-makers don't completely understand the direct and/or indirect impacts of their actions on creating company value.
EVA drivers can be used to solve these questions. They are nothing more than a break-down of EVA into its smallest components. For example, working capital can be dismembered in a way that reveals inventory turnover and receipt times. Operating costs can be analyzed from the viewpoint of raw-material productivity or labor cost per ton produced. Sales performance can be analyzed according to amounts sold, market share or average sales yield.
These drivers are correlated, and maximizing each indicator will not always entail a maximization of the end result. Three examples: 1) to improve the company’s results, the inventory manager has to increase the turnover of assets under his responsibility without ignoring the possible implications on product costs; 2) the accounts receivable area needs to be more efficient in order to reduce overdue receivables, but careful enough to avoid compromising commercial relations; and 3) the cost of labor per ton produced can be reduced by tracking its effect on inventory levels.
The structuring of an adequately balanced "drivers tree" enables collaborators to rapidly view the effects of their actions on several different areas besides the ones that they manage, observing an estimate of the company’s economic results. This tool also enables the results to be interpreted even by those that are not well versed in corporate finance concepts related to economic profit and company value.
So far we have described the financial drivers, but the same concept can be applied to non-financial items, such as customer satisfaction, service or product quality and strategic goals achievement.
Bringing the issue of alignment of interests presented at the beginning of the article into this context, we conclude that by using the elements from these "drivers trees" as significant element in mid and low level managers´ salaries, the decisions made far away from the top of the company will be in line with the value creation target, multiplying the opportunities for the business´s sustainable development.